Liquidity Risk Management

Objective of the E-BOOK 

  • To learn about the stock market risk   

Key Learnings from the Video

1. Meaning of Stock Market Risk

The term investment itself means risk because the return on investment is always a thing of concern. When an investor is investing in the Stock Market he/she taking a risk as an investment in the shares of the company may not mean high returns, this can also lead to a loss.

2. Types of Risks

The various types of risks are:

a. Systematic risk

Systematic risk is the risk that arises due to the fluctuations in the stock market of the country in which you are investing is known as systematic risk.

For example, if an investor is investing in the Indian stock market, then his/her investment can be at risk according to the movement/fluctuations in the stock market (like National Stock Exchange, Bombay Stock Exchange, etc.).

Systematic risk cannot be covered because it is caused due to a particular system which is in place.  The various situations which cause systematic risk are:

i. Pandemic: For the whole world as well as for India, the risk aroused due to Corona pandemic is considered as a systematic risk.  The pandemic has resulted in limited trade, no movement of goods, and no idea of how to do business. All this has caused the stock market to go down by 10% to 12%.

ii. Recession: A recession causes sudden de-growth, increased inflation, increased interest rates, etc., and impacts the whole system. It is a system-led recession and causes the entire market to go low. For example, the stock market corrected itself by 18% to 20% in the 2008 recession.

iii. Fluctuations in interest rates: The fluctuations in the stock market are directly related to the increase or decrease in the Repo rates, Reverse Repo rates, etc. as directed by the Reserve Bank of India (RBI).

iv. Increase in fiscal deficit: When the expenses of a country (defence, education, medical, road, etc.) exceed the revenue of a country (tax collection) it is termed as a fiscal deficit.  In such a situation a country has to borrow money from World Bank or other countries to meet the gap. A regular fiscal deficit causes systematic risk and pressure on the country too.  

v. Exchange rates: The difference between the exchange rates also causes fluctuation in the market.

vi. Inflation: Inflation causes a decrease in the value of money which further impacts the share market.

vii. Government decisions: Certain decisions of the government such as the “demonetisation decision” of the Indian government on 8th November 2016, lockdown, surgical strike, changes in regulations, changes in SEBI rules, geopolitical tension, negotiation between countries, etc. are part of systematic risk.

vii. Political turmoil: Instability or unstructured government also causes systematic risk.

viii. Natural disasters: Natural disasters like earthquakes or tsunamis are a part of systematic risk.

b. Unsystematic risk: The risks caused due to internal factors of a company are termed unsystematic risk.

For example, the management, cash flow, loan, employees, profitability, assets, etc. of Reliance company are its internal factors and cause fluctuations in its share value.

Unsystematic risk can be diversified by buying shares of diverse industries.

For example, Reliance shares have to face a negative effect due to a sudden decrease in crude oil prices because Reliance produces and sells crude oil in India.

A decrease in the price of crude oil may cause loss to Reliance but it will be profitable for Hindustan Petroleum (HP) as crude oil is a raw material for the company and will generate a high margin for HP.

An increase in the currency rate means profits for exporters whereas a loss for importers.

Diversification means investing in different shares of different sectors to minimize the risk. For example, the investor invests in Reliance as well as in Hindustan Petroleum. 

Unsystematic risk arises due to factors of company and business.

For example, a decrease in the prices of steel will create a problem for JSW steel as it deals in steel but if prices increase then JSW will earn profit.

In the case of steel prices, real estate companies will have a positive effect.

Unsystematic risk needs to be diversified as it causes loss to some companies whereas profit to other companies.

3. Risk Diversification of Stock Market

a. Add bonds to your portfolio to have a monthly income.

b. Do not invest in high volatile securities.

c. Invest systematically for long term investment plans like investments in mutual funds. The systematic investment gives the benefit of the snowball effect (the longer the time of investment gives higher returns).

d. Invest in index funds. This means the stock is not purchased directly but the index is purchased like NIFTY 50. The index is the amalgamation of the best companies of various sectors like ONGC, Hindustan Petroleum, ACC, Oberoi Realty, etc.

e. Buy shares and hold for a long time.

f. Avoid borrowing and never do investment by taking a loan to avoid interest burden.

Key Outcomes of the Video

  • Manage risk while doing stock market investment  
  • Diversify investment to mitigate risk
  • Do systematic investment to earn higher returns on investment
  • CRE GOES TO BADA BUSINESS 

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